As Q2 2023 draws to a close, the introduction of two landmark pieces of climate legislation will have significant implications for asset management firms investing in sustainable assets.
- Infrastructure Investment and Jobs Act was passed in Q4 2021 as a “once-in-a-generation investment in [US] Infrastructure” that will prepare the transition of the US economy to net-zero. The Act will invest an additional $550 billion in roads and bridges, water infrastructure, internet, and initiatives boosting climate resilience while renewing $450 billion of existing transportation funding. The Act also simplifies the permitting process for infrastructure projects to incentivize private investment in the future (White House, 2021).
- Passed in Q3 2022, the Inflation Reduction Act is a more climate-focused legislation that directs federal and private investment toward reducing emissions and lowering costs of healthcare. The Act provides around $400 billion of funding for clean electricity, transmission and transportation. The majority of climate funding will be distributed through tax credits to corporations (Senate Democrats, 2022).
Both laws are designed to create long-term investor demand for sustainable assets and both legislations encourage the use of public-private partnerships (PPP) with the goal of channelling private capital into public initiatives that promote climate resiliency and sustainability.
Federal regulatory agencies are also moving in lockstep with legislative efforts with two ESG-related rules proposed by the Department of Labor and the SEC that will directly impact asset managers:
- The Department of Labor proposed a Final Rule under the Employee Retirement Income Security Act (ERISA) that asserts a fiduciary’s duty of prudence may be based on factors such as “economic effects of climate change and other ESG considerations” for retirement plans. Investment companies have begun to review their investment process as the rule went into effect on February 1, 2023 despite a last-minute lawsuit launched by 24 states.
- SEC proposed Climate Disclosure Rules requiring SEC-reporting US and foreign companies to disclose climate-related risks in their annual reports in order to address a “lack of consistent, comparable and reliable information among investment products and advisers that claim to consider one or more ESG factors.”
The proposed rules are in line with the regulatory framework recommended by the TCFD in terms of the four main disclosure “pillars”: governance, strategy, risk management and targets /metrics. Furthermore, the proposed SEC rules require the additional disclosure of the following information:
- Climate transition plans if the firm has adopted one as part of its climate-related risk management strategy
- Specific and relevant climate-related items such as Scope 3 emissions (excluding offsets), GHG intensity, and an attestation report carried out by an independent provider.
The proposed SEC rules have drawn a large volume of public comments by persons and/or entities ranging from asset managers, oil and gas companies, bank, politicians, and NGOs. Some contentions have arisen from ESG sceptics in relation to SEC’s legal authority, costs vs benefits of regulation, compatibility with other disclosure standards and, materiality thresholds. However, overall market sentiment seems to indicate there is broad support for a standard ruleset for climate disclosure.
As the SEC revise and finalize these rules, firms must comply with the new regulatory regimes as they are developed. In preparation, there are several principles that firms can leverage to guide them through the uncertainty:
- Be ready to disclose – Are you prepared to disclose more to your clients about how you are embedding Responsible Investing (RI) principles; both at the point of sale and throughout client reporting? Are you disclosing using common standards and frameworks where available?
- Be ready for common standards – As common standards and taxonomies are being introduced, a robust governance process will be required to ensure initial and ongoing compliance.
- Enhance stewardship – Regulators are expecting firms to embed RI principles in their operating models and investment processes. Asset Managers are increasingly expected to actively engage with the assets they own to influence change.
- Consider client needs – Regulatory requirements by client type and location are both increasing and starting to diverge. It is expected that firms will need to demonstrate how they are capturing their clients’ RI requirements to demonstrate suitability of the investment selected.
- Be proactive with voluntary codes – Defining and maintaining a clear strategy for becoming signatory to volunteer codes is increasingly important to manage clarity of messaging and effort.
- Climate, climate, climate – Climate is currently squarely at the top of the regulatory agenda within Responsible Investment. It presents opportunities to work in partnership with regulators on “green innovation”, supporting regulatory objectives such the transition to a client-resilient economy and maximization of long-term benefit to consumers.
Alpha recommends two action items for firms to undertake to ensure compliance with regulations:
- Review the Global Compliance Operating Model of the organization including the definition of global policies and procedures, controls and IT architecture
- Conduct an Impact / Risk Assessment and weave in the concept of “double materiality,” meaning a firm should be prepared to disclose how its operations are affected by sustainability factors and how its activities are impacting the environment and society at large